I asked a guy at Thompson why there was such a disparity between what the market is pricing in and what I (and the analyst I emailed) thought would actually happen at the December meeting. His reply:

"The market is reacting to the dislocations in the short-term funding market (e.g., LIBOR, Asset-Backed Commercial Paper, etc). The FF futures market has about 15 bps (60% odds) of a possible 25 bps ease priced into the December contract. Because of year-end, we use the January contract which shows 96% odds of a 4.25% funds rate. So yes, there is a disparity between what we and the markets feel is the Fed's next move. We think the Fed could/ should increase liquidity and confidence in the financial markets (through changes in collateral types, overnight and term lending) without a decline in the funds rate. "

Interesting perspective.

Yep, I completely agree with that analyst. Things in money markets and corporate credit have shown substantial deterioration. We can see that in treasury-LIBOR spreads, as well as soaring Credit Default Swap prices and Treasury-Junk yield spreads.

Investors are plowing money into riskless Treasury bonds while increasingly reluctant lenders are effectively driving market yields higher.

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And how does cutting another 25bps make this all better? I guess I'm trying to understand the market's rationale and logic.

That's the thing. It doesn't really address the big issues at hand. Increased liquidity supplied by a boost in the money supply would theoretically ease pressures on market yields, but we didn't see that following the last rate cut, and I'm not sure we would see that on a further rate cut.

The Fed is essentially stuck between a rock and a hard place. It should theoretically boost the money supply so as to avert a lending market crisis and a truly pronounced housing recession, but a sharp rise in energy costs threatens to derail already fragile inflation expectations.

My point is that no matter how much they cut, risk will not be back in season any time soon. And that's what we're talking about here. The Fed has no magic wand to make banks and lenders unlearn the harsh lesson they learned in the last half of the year. They don't want risky vehicles right now, and that's not going to change.

Ivanovich, you wouldn't really have a hard time finding people that agree with you. While there are always some that say the Fed is useless, everything we've seen transpire over the past few months have only made those who watch what the Fed does more skeptical. A lot of these same people call for a return to the gold standard (which seems especially pertinent given the weakness of the USD).

I agree with you both. I don't think the FED can do all that much to turn the market sentiment or the economy around for some time. I think any rate cuts will only put a band-aid on a wound that needs stiches and time to work out it's own natural corrective healing process.
Terri, I don't know that we could return to the gold standard anymore...countries are switching from US to EUR now. If gold came back, the gold-rich countries' currency would soar, leaving the EUR on the backbench....???

I think the idea is to simply back the USD with gold, which would provide more confidence in the greenback as it would guaranteed by a tangible store of wealth. That isn't to say that other governments wouldn't follow suit, but I very much doubt the US would take this course anyway except in the event of the most desperate dollar crisis.

For some reason I can't open the PDF, but here is a link to a page that claims to list global official reserve holdings as of Sept 07: http://www.gold.org/value/stats/stat...hive/index.php

USD can never return to the gold standard. There are trillions of dollars floating around and gold supply is in a decline, the price of gold would have to be in the tens of thousands of dollars in order to be on par with the US's money supply. Most importantly though, the FED would lose all control of the monetary printing presses which would have to pump out as much dollars as there is gold. So not going to ever happen.

We posted the most recent "Watch what the Fed Watches" report this morning on DailyFX.com

http://www.dailyfx.com/story/special...670298758.html

Long story short? Things in financial markets have really worsened. Will this be enough to make the Fed relent? We shall have to see.

Concur. Additionally, locking the USD to a finite asset would essentially limit the wealth of the country. That is why countries abandoned it in the first place. If you have a finite amount of gold, and the population continues to grow at an exponential rate, the money can only spread out between the population. It can never grow.

I dissagree with that theory.....supply and demand would increase/decrease it's value. More exploration would go underway to satisfy supply needs (and greed needs for stockpiling) which would drive up the price. The same scenario for oil, eventhough oil and gold consumption is a little like comparing apples with peanuts. I think almost anything, if accepted globaly as a benchmark for "wealth" or "exchange" could be considered and then the supply/demand scenario would apply. However, I am sceptical that the gold standard would come back.

vnmonica, you've hit the nail on the head with your comment about working itself out. This is only the business cycle. Economies expand and contract. "The Invisible Hand" of the free markets that was written about in "The Wealth of Nations", needs the help of a central bank to make sure the cycle expands gently and contracts gently. Perhaps this time, the Fed didn't "take the punch bowl away" quite fast enough. But to panic and say we need the gold standard again may be a little drastic. We should let the EZ go through an entire cycle as well. Our economy has been here before and it will happen again.
The Fed is in a tough spot. One one hand, we have commodities inflating, on the other hand, they have to keep consumers spending.

-thomask

I think consumers will keep spending regardless of stagflation, recession or depression. There will always be a need and supply for the staple basket of goods and the majority of the population are just too spoiled and greedy not to keep buying. Sure big ticket items may slow, cars, houses, travel, but they won't stop completely. I think we've grown too accustomed to "buy now, pay later" to elevate our standard of living and those that live by that standard should be hit the hardest for living WELL BEYOND their means. There is a difference between spending/supporting the economy with prudend credit purchases and overdoing it.
But we don't have any control over inflation which eats up our spending money. Those of us who are not "spoiled" by all the nice things that money can buy (fixed income seniors, single parents, disabled or health problems) already have little or no choice in a low standard of living and should not continue to get hammered further because of high inflation.
Am I making any sense, or am I just rambling on???

Agreed. I only point the topic out to play devil's advocate. However, I think the more jittery the markets become about the stability of the US economy, financial markets, $, and effectiveness of the Fed, the more we'll see "solutions" such as these be discussed.

Unfortunately, it looks like the US government and the Fed have no intention of allowing 'the invisible hand' to do its work. It was announced early last week that the state of California would work with loan servicers (including Countrywide and GMAC) to freeze the rates on subprime mortgages (http://gov.ca.gov/index.php?/press-release/8147/). As far as I know, putting any sort of freeze on prices or rates blows up in your face eventually. I keep reading stories about 80 year old grandmothers who face foreclosure due to ARM resets, and believe me, that's incredibly sad and depressing. However, is making grandma a slave to her mortgage for the rest of her days going to help? There's no simple way to solve the problem, and I understand that pointing out the flaws without offering a solution is counterproductive, but I don't think this kind of government intervention is the way out.